Most of the tax treaties which India has signed with other countries contain a specific provision relating to non-discrimination of the foreign enterprises vis--vis an Indian entity.
The non-discrimination clause, in effect, provides that when tax is levied on a permanent establishment of any foreign enterprise, the taxation of such permanent establishment shall not be less favourable than the taxation of similar activity carried on by a resident of that country.
In other words, the same privileges and incentives will be available to a foreign companys permanent establishment as are available to a resident of that country. Similarly, no such conditions will be imposed on the permanent establishment of the foreign enterprise that are not applicable to a resident enterprise.
In the Indian context, Section 44C of the Income-Tax Act provides a limitation on deduction of head office expenses. Broadly speaking, head office expenses are allowed only up to 5 per cent of adjusted total income.
Accordingly, a non-resident while computing income in India cannot claim more than 5 per cent of its income as the head office expenditure. The issue for consideration is whereas there is a restriction on a non-resident to claim head office expenses, there is no such restriction on a resident tax payer. In this manner, this becomes a case of discrimination between a non-resident tax payer and a resident tax payer.
The above issue was raised in a recent case before the Mumbai Tribunal in Metchem Canada Inc vs CIT 284 ITR 196 (AT). In this case, a Canadian company entered into an agreement with an Indian company for erecting, commissioning and running of a project in Gujarat. The Canadian company claimed a deduction in respect of overhead expenses incurred by its head office.
The assessing officer disallowed the claim. The matter was taken to the tribunal. The core issue was whether or not the limitation on deduction of head office expenditure, as set out in Section 44C of the Indian Income-Tax Act, would apply in the case of non-resident companies governed by the India-Canada Double Taxation Avoidance Agreement (DTAA), particularly in the light of the non-discrimination clause in the said DTAA.
It may be clarified here that Article 24 of the DTAA relates to non-discrimination between a non resident and a resident. The tribunal, while interpreting the import of the non-discrimination article, extensively referred to the OECD commentary on such non-discrimination.
It was observed by the tribunal that the taxation on a permanent establishment of a Canadian company, by reason of placing a restriction on deduction of head office expenditure which is not applicable in the case of resident companies, does, therefore, constitute less favourable tax treatment in India than the taxation levied on Indian enterprise carrying on the same activities in India. Viewed in this perspective, it is clear that the limitation on deduction of head office expenditure, will be hit by the non-discrimination clause.
It was finally held: "We are of the considered view that a restriction on admissibility of head office overheads of permanent establishment of a Canadian company constitutes discrimination against such a permanent establishment vis--vis a domestic Indian entity because no such restriction is applicable for deduction of head office or controlling office overheads of an Indian entity."
It is to be noted that the non-discrimination clause exists in virtually all the tax treaties entered into by India with other countries. In all such cases, restriction on the claim of the head office expenses as contemplated in Section 44-C will remain non-applicable.
H P Agrawal